Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after briefly looking over the numbers, we don't think Associated British Foods (LON:ABF) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
Understanding Return On Capital Employed (ROCE)
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Associated British Foods:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.043 = UK£581m ÷ (UK£16b - UK£2.7b) (Based on the trailing twelve months to February 2021).
Thus, Associated British Foods has an ROCE of 4.3%. In absolute terms, that's a low return and it also under-performs the Food industry average of 11%.
Above you can see how the current ROCE for Associated British Foods compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Associated British Foods here for free.
What The Trend Of ROCE Can Tell Us
On the surface, the trend of ROCE at Associated British Foods doesn't inspire confidence. Around five years ago the returns on capital were 12%, but since then they've fallen to 4.3%. And considering revenue has dropped while employing more capital, we'd be cautious. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.
The Key Takeaway
From the above analysis, we find it rather worrisome that returns on capital and sales for Associated British Foods have fallen, meanwhile the business is employing more capital than it was five years ago. Investors haven't taken kindly to these developments, since the stock has declined 23% from where it was five years ago. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.
On a final note, we've found 2 warning signs for Associated British Foods that we think you should be aware of.
While Associated British Foods may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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